Listed Investment Companies aka LICs are an investment option offered within Australia. Today I will explain everything that you need to know about LICs. I will be covering what they are and whether or not they may be a good investment option for you.
Listed Investment Companies (LICs) are companies that are listed on the stock exchange that aim to generate income by investing in other companies on the stock exchange. Similar to ETFs, LICs offer a cost-efficient way of obtaining a diversified portfolio that can include multiple assets, commodities, currencies, sectors and bonds among others.
However, while LICs share a lot of similarities with ETFs, there are some distinct differences. LICs, for the most part, are actively managed, whereas ETFs are typically passive investments. Subsequently, while ETFs may attempt to mirror the performance of a particular benchmark or index, LICs generally aim to outperform those indexes. LICs aim to achieve this through a team that actively manages your money, their ability to effectively or ineffectively manage the fund will result in the overall value of the LIC.
Because LICs are actively managed, the management expense ratio (MER) is generally higher than that of most ETFs. This is primarily because fund managers of LICs are actively attempting to beat the market through the selling and purchasing assets at different times, resulting in higher management fees.
If you would like more information on ETFs, I cover them in more detail here:
Another key difference between ETFs and LICs are that ETFs are open-ended whereas LICs are closed-ended. As ETFs are open-ended, they can create and redeem units based on the demand of the share market. However, LICs are closed-ended which means that there is a finite supply of shares.
A potential benefit of LICs being close-ended is that their share price can trade at a large premium or discount to their net asset value (NAV). ETFs utilise a market marker which is used to ensure that the price investors pay for units are closely correlated to the NAV, which is updated daily.
Conversely, LICs typically only produce their NAV in the form of a monthly report. This means that the price of LICs can be based on what investors are willing to pay on that given day, resulting in a potential premium (paying above the NAV) or discount (paying below the NAV). Subsequently, you as an investor can purchase LICs at a discount to attempt to optimise profits.
Dividends are another important factor to consider when looking into LICs as they offer some unique benefits compared to other forms of investments. Firstly, a LIC distributes its income when its board declares one and in this sense, they are not obligated to maintain a consistent dividend yield or rate of payment. This differs significantly from ETFs which operate under a trust, where they are obliged to return all of its income each year.
The negative to this is that a board can simply not declare a dividend or reduce the annual yield depending on how the LIC is performing. However, a benefit for dividends offered by LICs is that because they operate as an Australian company, they pay the corporate tax of 30%. This means that they typically offer fully franked dividends, which can have some great taxation benefits depending on your income bracket.
Another unique feature offered by LICs is that some offer the opportunity to accumulate additional shares instead of a dividend through Dividend Substitution Share Plans (DSSP) and Bonus Share Plans (BSP). While this may sound similar to a dividend reinvestment plan (DRP), which occurs when you reinvest the dividend towards purchasing additional shares, a DSSP and BSP differ from a DRP as the additional shares are offered in place of the dividend.
This means that the shares are not viewed as taxable income as they would be under a DRP or cash dividend. While this is less relevant for low-income earners as a fully franked dividend would be refunded to them in full, it has significant tax advantages for people in tax brackets above the corporate tax of 30%. The reason for this is that through not paying tax on dividends and utilising these plans, you grow the number of shares that you hold at a faster rate than through a DRP or using a cash dividend to purchase more shares.
LICs offer a cost-efficient way of diversifying domestically, as they can hold multiple assets, commodities, currencies, sectors and bonds through companies listed on the ASX. They also have unique tax advantages as seen through DSSP and BSP, in addition to the majority of their dividends being fully franked.
Additionally, as their sole business is through investing in others, they offer the possibility of outperforming the market and subsequently, have the potential to outperform ETFs. However, this potential extra return comes at the expense of higher MER, limited international diversification and the risk that despite the higher MER, that they do not outperform the market.
Depending on your tax bracket, your investment horizon, your FIRE goals, your portfolio diversification and your faith in LIC managers being able to consistently beat the market will dictate whether you decide to incorporate them into your investment portfolio.
If you would like to invest in LICs or ETFs, I recommend using SelfWealth. As it offers the lowest flat-rate brokerage fees among any CHESS-sponsored trading platform in Australia. For more information, you can find my in-depth review on SelfWealth Here.
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